New inheritance tax disclosure regime
Inheritance tax planning just got a whole lot more complicated.
After the Disclosure of Tax Avoidance Schemes (DOTAS) came into effect for inheritance tax on 1 April 2018. The regulations are likely to prove difficult to apply in practice. They are not confined to ‘schemes’ as such and may need to be considered in all but the most straightforward IHT planning from now on.
The rules are intended to act as an early warning system for HMRC of tax avoidance arrangements and how they work. Disclosure is required as and when they are devised rather than when they eventually come to light, for example in a tax return.
While the system identifies the users of schemes, it is not designed to have any immediate impact on the tax position of the client or to short-circuit normal reporting obligations. The primary aim is to give HMRC notice of what taxpayers are doing in practice and provide an opportunity to clamp down on the future use of schemes by others. HMRC guidance points out that any legislation could have retrospective effect and impact previous scheme users, although that would be unusual. Furthermore, the onerous deadlines for making a disclosure, administrative burden and other consequences generally will serve as a deterrent to some taxpayers from engaging in a notifiable scheme in the first place.
What needs to be disclosed?
Tax avoidance is an emotive subject yet there is little consensus and no single, official definition of tax avoidance in the UK. For these purposes, arrangements need to be disclosed if an informed observer, having studied the arrangements and having regard to all the circumstances, could reasonably conclude that two conditions are met.
The first condition is that a main purpose of the arrangements is to enable someone to obtain an IHT ‘advantage’. This is specifically defined to include:
- the avoidance or reduction of one of the IHT charges that applies to certain trusts (e.g. the ‘entry’ or ‘exit’ charge or ten-year anniversary charge);
- the avoidance or reduction of an IHT charge under the reservation of benefit provisions; or
- the reduction in a person’s estate which is neither an immediately chargeable transfer nor a potentially exempt transfer (e.g. a gift that will be exempt if the donor survives for seven years).
This first condition is wider than you would imagine. It can apply where the tax advantage is the use of an IHT exemption, such as the spouse exemption, or use of a statutory let-out, such as a gift of a share of land coupled with joint occupation of the property. Therefore it is necessary to test some quite anodyne arrangements against the second condition which is much more difficult to discern.
The second condition is that the arrangements involve one or more contrived or abnormal steps without which the tax advantage could not be obtained.
It will be difficult to determine what is contrived or abnormal in any given situation. These terms are not defined in the legislation. HMRC’s guidance contains the following examples of arrangements they regard as being contrived or abnormal and which now need to be disclosed:
- reversionary leases which avoid pre-owned assets tax; and
- the transfer of qualifying business property into trust with a pre-ordained plan to sell back to the donor with a view to putting cash into trust tax-free.
HMRC also say that gifts of part of a property where only a very small portion of the property is retained relative to the donor’s continued occupation with the donee might need to be disclosed.
Another area of difficulty is that the contrived and abnormal steps must be judged from the viewpoint of an ‘informed observer’, which is not defined either. HMRC guidance suggests this is an independent person with sufficient knowledge and skill to understand both the scheme and the relevant tax rules, though not necessarily an expert or tax practitioner.
The new disclosure requirement broadly only applies to arrangements proposed by advisers or made available or implemented after 1 April 2018. There is an exception for arrangements that are similar to those entered into before that date which were ‘established practice’ accepted by HMRC but the guidance explains that only applies if the current arrangements implement exactly the same proposal as the previously accepted arrangements. Again there is no definition of ‘proposal’ but the guidance suggests that the exception will only apply in very limited circumstances and rarely to any bespoke IHT planning.
The HMRC guidance sums up that “normal and straightforward IHT planning is not notifiable”. That would seem obvious but begs the question of what is ‘normal’ in the context of an individual’s personal circumstances? The latest guidance provides few clues and so this is likely to be a vexing issue for advisers and taxpayers alike for some time to come.
Published in 2018 and updated in 2020.